NEW YORK (Reuters) - U.S. Mid-Atlantic factory activity retrenched for the first time in over three years in September, the latest sign of a rapidly-slowing economy.

The Philadelphia Federal Reserve Bank said on Thursday its business activity index tumbled to -0.4 this month from 18.5 in August, far below forecasts of around 14.8.

It was the first reading below zero since April 2003, indicating a sharp decline in regional manufacturing.

"We're seeing signs in the Philadelphia survey that the economy is cooling off," said Gary Thayer, chief economist at A.G. Edwards & Sons.

The entire survey was deemed very weak with new orders also slipping into negative territory. The six-month business outlook turned gloomy as well, showing its first negative reading since just before the last U.S. economic recession.

"The region's manufacturing executives were significantly less optimistic about future activity, with most indicators dipping to their lowest readings in six years," the Philly Fed survey said.

The regional survey is one of the first indicators of U.S. manufacturing of every month and is often used as a guidepost to the health of factories nationwide. It covers eastern Pennsylvania, southern New Jersey and Delaware.

In one area of relief, prices paid by manufacturers eased as energy prices came off record highs. Crude oil futures have fallen dramatically since March, from around $78 to its current level near $61 per barrel. The employment index also improved modestly, rising to 10.7 from 8.2.

Nonetheless, investors were startled by the unexpected pullback, selling the dollar in earnest and jumping into government bonds, which tend to be a safer bet in tough economic times. On Wall Street, stock prices <.DJI> also veered lower.

The survey added to evidence that the U.S. economy is entering a rough patch led by a sharp slowdown in the housing sector, which is expected to take a toll on consumer spending.

Many economists had been counting on business investment to pick up where consumers left off. The Philly data, however, at least suggest this hand-off has so far failed to take place.